Retiree health-care accounting rule may become bitter pill

Millions of public employees, from teachers to transit workers, enjoy a benefit that fewer private sector workers can claim these days--lifetime medical coverage.

No one is certain how much it will cost to provide these benefits down the road because few public employers have done the math. But sticker shock is about to set in.

Under a new accounting rule, public employers will be required to report not just what they spend annually on retiree medical care but to estimate the total tab for promised retiree health-care benefits--a move that will spotlight billions in future costs.

The change will prompt more employers to try to trim this large and growing liability by cutting benefits, prompting clashes with unions, experts predict. And there will be a new day of reckoning with taxpayers and bondholders for cash-strapped state and local governments that must draw up plans to fill a gaping long-term budget hole.

"The impact is going to be huge," predicted John Bauman, executive director of the Illinois Teachers' Retirement System in Springfield.

Actuary Stephen McElhaney, a principal at Mercer Human Resources, estimates that when all state and local governments and public agencies finish their tallies, the national total could run as high as $1 trillion.

"It's going to be a big event for most public employers," he said.

The rule change, to be phased in over three years, is effective next year for employers with more than $100 million in revenue, which includes the State of Illinois and dozens of larger cities and counties.

It comes at a time when Illinois officials are struggling to plug a multibillion-dollar shortfall in the state's pension funds, which are among the most poorly funded in the country.

Employers will not have to start setting aside money now to cover retirees' future medical costs, as they do for pensions. But they must disclose how they plan to pay for these long-term liabilities, which are growing faster than other expenses because of spiraling health-care costs and aging workforces.

"We're going to be watching to see how they manage this issue," said Parry Young, analyst at credit-rating agency Standard & Poor's.

The greater the likelihood of default, the lower a government's bond rating and the higher its borrowing costs.

Bond ratings

"The rule could affect bond ratings, and we think it will," said Frederick Nesbitt, executive director for the National Conference on Public Employee Retirement Systems.

Few governments have started the calculations, say actuaries and public officials. At the State of Illinois the rule will kick in for the fiscal year starting July 1, 2007.

"Right now we are much more focused on keeping the existing budget balanced," said state budget director John Filan. "We are right on top of our current costs, which are really what is relevant."

The state spent about $522 million on health care in fiscal 2005 for 74,500 retirees. If the state were to set aside money for benefits as they accrue during employees' working years, the annual cost for retiree health care likely would be more than $1 billion, actuaries estimate.

This type of calculation will become standard under the new accounting rule.

In Cook County, unlike most governments, the pension fund decides whether to subsidize retiree health care and calculates the cost. The fund is spending about $35 million annually for retiree medical care, and the estimated accrued liability, the total future cost of retiree benefits for employees currently, is about $463 million, said Jack Fitzgerald, pension fund executive director.

County officials say this hefty liability--more than 20 percent of the county's $2.16 billion operating budget--doesn't belong on the county's books because the county board never approved the benefits.

"This will definitely be a conversation with our auditors," said county Chief Financial Officer Thomas Glaser. "Based on a legal opinion, it won't be on our financial statements."

In Chicago, which spent an estimated $88.5 million last year on medical care for 24,500 retired police, firefighters and other city workers, officials expect to have a plan for the new disclosure within six months, a Finance Department spokeswoman said. The city must comply in its fiscal year starting Jan. 1, 2007.

In the handful of states that already have calculated their accrued liability, the numbers are sobering.

Michigan, which began estimating this cost voluntarily in the late 1990s, estimates its obligations to teachers, judges, state troopers and other government employees total about $23 billion.

Like most public employers, Michigan operates on a pay-as-you-go basis and the tab for retiree medical care was $650 million in 2004. The annual cost would more than double to $1.5 billion on an accrual basis, said Chris DeRose, director of Michigan Retirement Systems.